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Sovereign Debt Restructuring: a Model-Law Approach

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Sovereign Debt Restructuring: a Model-Law Approach JGD 2016; aop Steven L. Schwarcz* Sovereign Debt Restructuring: A Model-Law Approach DOI 10.1515/jgd-2015-0031 Abstract: Unlike individuals and corporations, countries indebted beyond their ability to pay cannot use bankruptcy laws to restructure unsustainable debt. The United Nations and the International Monetary Fund have attempted to propose treaties to enable that debt restructuring, but the political difficulties of reaching a worldwide consensus have stymied their efforts. This article argues that a model- law approach to restructuring unsustainable sovereign debt should be feasible and effective because the vast majority of sovereign debt contracts are governed by the laws of either the debtor-state or two other jurisdictions. Those jurisdic- tions individually could enact a model law to give struggling nations a real pros- pect of equitably restructuring their debt to sustainable levels. By ena bling such debt restructuring, that enactment would also help to foster the norms required to facilitate the development of international treaties. 1 Introduction Recent court decisions in the UK regarding the illegality of exit consents1 and in the US regarding pari passu clauses in Argentine sovereign debt,2 as well as 1 The Chancery Division of the English High Court held, in the Anglo Irish case Assénagon Asset Man- agement S.A. v. Irish Bank Resolution Corporation Limited (formerly Anglo Irish Bank Corporation Lim- ited) [2012] EWHC 2090 (Ch), that exit consents are illegal, casting doubt on the effectiveness of exit consents to restructure debt under English law. See, e.g. Patrick S. Kenadjian, The Aggregation Clause in Euro Area Government Securities, in Collective Action Clauses and the Restructuring of Sovereign Debt 143 (Patrick S. Kenadjian, Klaus-Albert Bauer and Andreas Cahn, eds. 2013) (observing that the judge in the Anglo Irish case “held that it was not lawful for the majority to aid in the coercion of a mi- nority by voting for a resolution which expropriates the majority’s rights for nominal consideration[,] thus cast[ing] doubt on the legality under English law of any form of exit consent that imposes less favorable conditions on those who refuse to par ticipate in the associated exchange offer.”). Al though exit consents have been severely criticized in the US, they have survived judicial challenges made by minority bondholders. See Katz v. Oak Indus. Inc., 508 A.2d 873 (Del. Ch. 1986). 2 NML Capital, Ltd. v. Republic of Argentina, No. 08–CV–6978 TPG, 2012 WL 5895786 (S.D.N.Y. Nov. 21, 2012) (holding that the pari passu clause in Argentina’s defaulted bonds contract *Corresponding author: Steven L. Schwarcz, The Stanley A. Star Professor of Law and Business, Duke University School of Law, P.O. Box 90360, Durham, NC 27708-0360, USA, e-mail: schwarcz@ law.duke.edu; and The Centre for International Governance Innovation (CIGI), Waterloo, Canada Brought to you by | Duke University Authenticated Download Date | 2/23/16 9:31 PM 2 Steven L. Schwarcz the ongoing Greek debt crisis, have dramatically highlighted the risks of an inad- equate legal resolution framework for restructuring unsustainable sovereign debt.3 Even those who are not adherents of sovereign “bankruptcy” believe that the status quo contractual approach is “deeply dysfunctional and produces bad law.”4 Unresolved sovereign debt problems are hurting individual debtor nations and their citizens, as well as their creditors.5 A sovereign debt default can also pose a serious systemic threat to the international financial system.6 Few dissent from these views.7 The main impediment is that the existing “contractual” approach to sover- eign debt restructuring – the use of so-called collective actions clauses (“CAC”s) – “ prohibits Argentina, as bond issuer, from formally subordinating the bonds by issuing superior debt” and “prohibits Argentina, as bond payor, from paying [restructured] bonds without paying on the [holdout] Bonds”). Thus Argentina must pay all outstanding sums on its defaulted bonds simultaneously if it makes any payment on its restructured bonds. That decision was affirmed in its entirety by NML Capital, Ltd. v. Republic of Argentina, 727 F.3d 230 (2d Cir. 2013), cert. denied in Republic of Argentina v. NML Capital, Ltd., 134 S. Ct. 2819 (2014). 3 For an analysis of what constitutes “unsustainable” sovereign debt, see text accompanying notes 90–93, infra. This article refers to a nation obligated to repay that debt as a “debtor-state.” 4 Anna Gelpern, A Skeptic’s Case for Sovereign Bankruptcy, in A Debt Restructuring Mechanism for Sovereigns: Do We Need a Legal Procedure? 262 (Christoph Paulus, ed. 2014). 5 Cf. Joseph E. Stiglitz et al., Frameworks for Sovereign Debt Restructuring, IPD-CIGI-CGEG Policy Brief from a November 17, 2014 conference held at Columbia University, at 1 (stating that “[p]oorly designed arrangements for resolving sovereign debt problems can lead to inefficiencies and in- equities . Delays in restructuring can be very costly. Insufficiently deep restructuring can force the economy through multiple crises and restructuring – at a high cost.”). 6 See, e.g. Jay L. Westbrook, Sovereign Debt and Exclusions from Insolvency Proceedings, in A Debt Restructuring Mechanism for Sovereigns: Do We Need a legal Procedure?, at 251 (Christoph Paulus, ed. 2014). Cf. e-mail from Eva Hüpkes, Adviser on Regulatory Policy and Cooperation at the Financial Stability Board (FSB), to the author (July 14, 2015) (observing that “doubts about the ability of states to provide additional resources can make financial institutions more fragile, in particular where there are no regimes in place that provide authorities with powers and tools to resolve financial firms without use of public funds”). 7 One prominent dissenter is Hung Tran, the executive managing director of the Institute of Inter- national Finance (IIF). Tran argues that all of the ad hoc bond restructurings since the first bond exchange of modern times (Mongolia 1997) have worked reasonably well, with the exception of Argentina in the 2000s. Hung Tran, Presentation at the Peterson Institute for International Eco- nomics (April 8, 2014), available at http://www.iie.com/events/event_detail.cfm?EventID=318. He admits that the existing market-based approach is not perfect. However, he contends that breaking contracts should not be easy to do and that making sovereign debt restructuring less costly will inadvertently increase moral hazard by motivating nations to engage in riskier bor- rowing; and that, in turn, would eventually lead to more defaults – which would increase the cost of sovereign debt and make the development of emerging markets more challenging. Ibid. Brought to you by | Duke University Authenticated Download Date | 2/23/16 9:31 PM Sovereign Debt Restructuring: A Model-Law Approach 3 is insufficient to solve the holdout problem.8 CACs are clauses in debt contracts that enable a specified supermajority, such as two-thirds or three-quarters, of the contracting parties to amend the principal amount, interest rate, maturities, and other critical repayment terms.9 The holdout problem is a type of collective action problem in which certain creditors, such as vulture funds, refuse to agree to a reasonable debt restructuring plan that proposes to change critical terms, hoping to receive more than their fair share of a settlement.10 For several reasons, CACs are insufficient to solve the holdout problem. Notwithstanding decades of efforts to include such clauses in sovereign debt contracts, many contracts lack them, requiring unanimity to change criti- cal repayment terms – and thus enabling any party to the contract to act as a holdout.11 Even in sovereign debt contracts that include CACs, the supermajority requirement may be so high (e.g. three-quarters) that vulture funds are able to purchase vote-blocking positions that enable them to act as holdouts.12 Finally, a CAC ordinarily binds only the parties to the particular contract that includes it. The parties to any given sovereign debt contract therefore could act as holdouts in 8 Westbrook, supra note 6, at 255. For a discussion of the variety of issues that cannot be solved by CACs, see Guzman, Martin and Joseph E. Stiglitz (2016). “Fixing Sovereign Debt Restructur- ing”, in Too Little, Too Late: The Quest for Resolving Sovereign Debt Crises; Chapter 1. Columbia University Press. New York. Forthcoming. 9 Steven L. Schwarcz, Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach, 85 Cornell Law Review 956, 960 (2000), also available at http://scholarship.law.duke.edu/faculty_ scholarship/508/ (hereinafter “Sovereign Debt Restructuring”). 10 Ibid. Economists regard this as a form of “rent-seeking” behavior. Kenneth M. Kletzer, Sover- eign Bond Restructuring: Collective Action Clauses and Official Crisis Intervention, IMF Working Paper, at 4 (2003). 11 Steven L. Schwarcz, Sovereign Debt: The Statutory Solution, International Financial Law Re- view (Dec. 2014b); also available at http://www.iflr.com/Article/3405641/Sovereign-debts-statu- tory-solution.html. Cf. Text accompanying note 98, infra (observing that even after years of trying to include CACs, relatively few Greek debt agreements actually contained such clauses). 12 See, e.g. John A. E. Pottow, Mitigating the Problem of Vulture Holdout: International Certifica- tion Boards for Sovereign Debt Restructurings, Law & Economics Working Papers 81 (2013), avail- able at http://repository.law.umich.edu/law_econ_current/81 (vulture funds “may easily be able to marshal blocking positions, especially when a sovereign has issued multiple rounds of debt”). Cf. John Muse-Fisher, Starving the Vultures: NML Capital v. Republic of Argentina and Solutions to the Problem of Distressed-Debt Funds, 102. Cal. L. Rev. 1671, 1707 (2014) (illustrating how holdouts can “bid up the price of defaulted bonds in order to achieve a blocking position”); Molly Ryan, Sovereign Bankruptcy: Why Now and Why Not in the IMF, 82. Fordham L. Rev. 2473, 2502 (2014) (stating that “Greek bonds governed by UK law restructured in 2012 contained a CAC, but holdout investors successfully purchased blocking minorities in individual bond series that could not be offset by pro-restructuring majorities”).
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